Fracking has caused an uproar in local communities and split some in two. It has brought environmentalists to a boil. It allegedly caused tap water to go up in flames. A documentary was made in its honor. It caused earthquakes in Oklahoma and other places. It caused Wall Street to froth at the mouth. And now it is causing the balance sheets of oil and gas companies to blow up.
It always starts with a toxic mix. Now even the Energy Department’s EIA has checked into it and after crunching some numbers found:
Based on data compiled from quarterly reports, for the year ending March 31, 2014, cash from operations for 127 major oil and natural gas companies totaled $568 billion, and major uses of cash totaled $677 billion, a difference of almost $110 billion.
To fill this $110 billion hole that they’d dug in just one year, these 127 oil and gas companies went out and increased their net debt by $106 billion. But that wasn’t enough. To raise more cash, they also sold $73 billion in assets. It left them with more cash (borrowed cash, that is) on the balance sheet than before, which pleased analysts, and it left them with a pile of additional debt and fewer assets to generate revenues with in order to service this debt.
It has been going on for years. In 2010, the hole left behind by fracking was only $18 billion. During each of the last three years, the gap was over $100 billion. This is the chart of an industry with apparently steep and permanent negative free cash-flows:
And those shortages in each year forced the companies to raise more debt and sell assets to fund more drilling, other capital expenditures, operational costs, dividends, and stock buybacks.
Of the three sources of cash – operations, net increase in debt, and asset sales – during the first quarters going back six years, net increases in debt accounted for over 20% of the incoming cash since 2012. For instance, In 2013, cash from operations supplied only 60% of the cash needs; most of the rest was borrowed, and some was covered by asset sales:
The EIA was quick to minimize the issue, claiming that this debt that has been spiraling out of control wasn’t “necessarily a negative indicator.” That low interest rates allowed companies to get fresh debt capital to cover their operational cash shortages. And that piling on debt “to fuel growth is a typical strategy, particularly among smaller producers.” And besides, this ballooning debt would be “met with increased production, generating more revenue to service future debt payments.”
This is where debt smacks into fracking. Fracked wells have nasty decline rates. They differ from well to well, with some estimates pegging the average declines at 50% to 78% by the end of the first year. After a few years, production might be down to less than 10% of production in the first year. In other words, the cash that has been drilled into ground has to be earned back within a terribly short time and has to be used to pay off the debt incurred in drilling the well. If not, the debt is left over, when the well is producing just a trickle.
This is exactly what is happening. It’s a horrendous treadmill. Just to maintain production, companies have to drill more and more and incur more and more debt, even as revenues are disappointing. In addition, drillers with heavy reliance on natural gas have faced prices for dry gas that have been so low for years that most wells will never generate enough cash to cover the costs of production. And much of the capital that went into them has been destroyed.
A Bloomberg analysis of 61 companies drilling for shale oil and gas found that debt among them nearly doubled over the past four years, while revenues inched up only 5.6%. And interest payments on that ballooning debt is taking up an ever larger portion of the revenues – even at today’s record low interest rates – with 12 of the companies already paying over 10% of their revenues in interest.
The financial hype around fracking, the limitless, nearly free liquidity provided by the Fed since late 2008, and investors so desperate for yield that they’re willing to incur just about any risks in their vain battle to come out ahead have had Wall Street frothing at the mouth. The sweeps of creative destruction have broken down. Instead, the boundless stream of money has been searching for a place to go, and it went to an economic activity – fracking – where money goes to die. What’s left is debt, and wells, especially gas wells, that will never produce enough to pay off the debt that was incurred to drill them.
These binges can go on for a long time, for far longer than a sane person in normal times would think possible. But with revenues barely growing, cash flows from operations stagnant, and debt levels that are soaring, at some point, something has to give.
Fracking isn’t the only place where the Fed’s policies created havoc: homeownership hit the skids when homes became a highly leveraged asset class, flipped and laddered by speculators, rather than lived in by normal folks. Read…. Here’s the Chart that Shows Why the Housing Market Is Sick
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Well said Wolf…
More corporate short term (as in executive bonus focus) thinking to feed the 1%… and when things blow up they’ll just sit back and enjoy the double digit returns in fixed interest vehicles… of course far too late to save Grandma and Grandpa!
Your message is very important!
In my view, we especially need to be very concerned about environmental harm from fracking.
Fracking has not only resulted in an exponential increase in the number of oil and natural gas wells that have been drilled, it has also resulted in an unknowable increase in pollution and the harm from it.
Oil and gas wells always leak methane which is harmful to the environment and ground water. In addition, they produce hazardous waste.
Paradoxically, during the Regan administration the US Congress and the US Environmental Protection Agency determined to classify oil field waste as non-hazardous, thus exempting it from tight hazardous waste controls. Hence, individual states are left to manage it. That management is generally lax as environmental interests are no match for corporate lobbying. Anecdotally, some horror stories emerge.
Environmentalists in North Dakota have expressed concern that discarded well filters have tested highly radioactive, and local non-hazardous waste landfill operators have had to install radiation detectors to combat the illegal disposal of such filters mixed with non-hazardous waste.
In Pennsylvania numerous oil and gas wells have surreptitiously been tested and found to contain high levels of radium which is highly radioactive. Some municipal waste water treatment plants in Pennsylvania have complained that radioactive waste water from fracking has been discharged to their waste water treatment plants. Such plants are not only unequipped to treat it, but their biological treatment processes are harmed by the radiation.
It is a pity that fracking is being promoted by our government as the solution to our energy needs when it has both adverse economic and environmental issues that are being ignored.
Robert Rapier gets into this a little bit …
“Just to put the current US oil boom into further perspective, over the past five years global oil production has increased by 3.85 million bpd. During that same time span, US production increased by 3.22 million bpd — 83.6 percent of the total global increase. Had the US shale oil boom never happened and US production continued to decline as it had for nearly 40 years prior to 2008, the global price of oil might easily be at $150 to $200 a barrel by now. Without those additional barrels on the market from (primarily) North Dakota and Texas, the price of crude would have risen until supply and demand were in balance.”
I as I said below, fracking is an old tech from the 80s that never made any sense economically. This is part and parcel with the can kicking going on at the macro level (QE, etc) for the reasons quoted above. The economic losses are very easy to paper over in a QE/low rate environment, but as Wolf shows above the losses will continue to pile up and will eventually implode the companies to which the debts belong … and that will trim production … and then oil prices will adjust to some sort of balance.
Rough seas ahead!
Fracking today makes no more economic sense for the country as a whole than in 2007-2008 it made sense to give a 500K mortgage to a minimum wage fast food worker to buy a McMasion.
In both instances it made no sense for the country but it did/does make economic sense for the crony capitalists who sell the overvalued securities to our pension funds and take bloated fees, bonuses, options and salaries for their “valuable” services thereby draining corporate assets and leaving behind a bankrupt shell. The pension fund managers must know it makes no sense for the rest of us otherwise they would not conceal the information under a veil of secrecy.
When the tapering on QE will be done, interest rates will go up and servicing debts on dwindling revenue will be impossible. So we will se defaults, and a chain reaction of defaults along the financial fabric.
Here we have the Subprime (oil) Financial Meltdown version 2.0 preparing for us.
Thanks for digging this up. The story is well known out here in alt land but I’d never seen the numbers. Now we have them.
It needs to be mentioned that the company executives pay themselves very handsome salaries and in the end this as much as anything explains why the treadmill continues to move. And why shouldn’t they make good money because this production is a strategic plus for the government. Not just the PR bonanza but its helping lower and smooth the cost of energy domestically and thus allowing the management of the markets to be easier. One hundred billion a year is not that big a cost in the big picture. Eventually someone will lose but not the players so they keep dancing.
Your phrase – “One hundred billion a year is not that big a cost in the big picture. Eventually someone will lose but not the players so they keep dancing.” – is one of the best explanations for why this has been going on for so long.
Yeah, a comments section!
Good to see someone run with the financial angle on this. I have stated repeatedly (just in blog comments, etc) that gas fracking is only enabled by extremely low interest rates and stupid investors with too much money. People often don’t realize this is a 1980s technology; it just never made economic sense so it never deployed to the field.
When rates go up and/or the stupid money dies, gas fracking will implode. The big boys will come in and scoop up the prized assets at fire sale prices and the rest of the carcass these companies leave behind will rot.
Oil and wet gas fracking is a different critter as those commodities fetch much higher prices.
What is curious, if you want something to go dig on, is the push to get coal out of the energy picture, particularly in power generation. There are plenty of mainstream stories about how companies are changing over to gas, relocating to presently low dollar/gas rich areas, etc. It almost feels like the power elite insiders are allowing nat gas prices to crater (on cheap debt as illustrated) while they set up coal interests to BK thus shedding legacy liabilities in restructuring. When gas prices return to normal, particularly in the US, many folks will realize their getting the electricity from gas and their electricity costs will adjust accordingly.
Coal will look a lot more friendly when folks can’t afford their utility bills. All it takes is a little politicized government policy change and voila, king coal is back.
What happens to the ability to service the debt if the price of oil and or natural gas were to drop by 40%?
At this point, they’re already servicing part of their old debt with new debt, rather than with cash from operations. So an even scarier question is – and it gets a lot scarier when the price drops 40%: What happens when they can’t get enough new money to service the old debt?